Intent to Reconcile: SEC v. Obus, the Second Circuit's Edification of the Tippee Scienter Standard

American University Law Review Volume 62 | Issue 3 Article 7 2013 Intent to Reconcile: SEC v. Obus, the Second Circuit's Edification of the Tippee Scienter Standard Allison M. Vissichelli American University Washington College of Law Follow this and additional works at: http://digitalcommons.wcl.american.edu/aulr Part of the Law Commons Recommended Citation Vissichelli, Allison M. "Intent to Reconcile: SEC v. Obus, the Second Circuit's Edification of the Tippee Scienter Standard." American University Law Review 62, no.3 (2013): 763-778. This Notes & Casenotes is brought to you for free and open access by the Washington College of Law Journals & Law Reviews at Digital Commons @ American University Washington College of Law. It has been accepted for inclusion in American University Law Review by an authorized administrator of Digital Commons @ American University Washington College of Law. For more information, please contact . Intent to Reconcile: SEC v. Obus, the Second Circuit's Edification of the Tippee Scienter Standard This notes & casenotes is available in American University Law Review: http://digitalcommons.wcl.american.edu/aulr/vol62/iss3/7 VISSICHELLI.OFF_TO_WEBSITE (DO NOT DELETE) 2/28/2013 1:32 PM INTENT TO RECONCILE: SEC V. OBUS, THE SECOND CIRCUIT’S EDIFICATION OF THE TIPPEE SCIENTER STANDARD ALLISON M. VISSICHELLI∗ TABLE OF CONTENTS Introduction ........................................................................................ 763 I. Background .............................................................................. 765 A. Liability for Insider Trading: An Overview of the Supreme Court’s Interpretation of Section 10(b) and Rule 10b-5 .......................................................................... 765 B. Tippee Liability Under Section 10(b) and Rule 10b-5: The Scienter Element and the Apparent Conflict Between Dirks v. SEC and Ernst & Ernst v. Hochfelder ....... 768 II. SEC v. Obus ................................................................................ 770 A. Facts and Procedural History ............................................ 770 B. The Second Circuit’s Decision ......................................... 772 III. Applying Two Different Standards of Awareness Results in a Logical Incongruity and Is Inconsistent with Insider Trading’s Connection to Fraud ............................................... 774 Conclusion .......................................................................................... 778 INTRODUCTION On September 6, 2012, the U.S. Court of Appeals for the Second Circuit resurrected a $1.3 million enforcement action initiated by the U.S. Securities Exchange Commission (SEC) against, among others, ∗ Associate Managing Editor, American University Law Review, Volume 62; J.D. Candidate, May 2013, American University Washington College of Law, B.S., Environmental Studies and Political Science, 2008, Gettysburg College. I am grateful to the talented members of the American University Law Review for their time and efforts in preparing this piece for publication. In particular, I thank Brian Shearer, Estefanía San Juan, Pasha Sternberg, Joanna Breslow, Jay Curran, Jess Portmess, and Kat Scott for their invaluable contributions. I dedicate this piece to my parents whose unwavering support both inspires and humbles me; at the risk of sounding cliché, no thanks will ever be enough. 763 VISSICHELLI.OFF_TO_WEBSITE (DO NOT DELETE) 2/28/2013 1:32 PM 764 [Vol. 62:763 AMERICAN UNIVERSITY LAW REVIEW Wynnefield Capital, Inc. founder Nelson Obus.1 Finding that the SEC provided sufficient evidence to create genuine issues of material fact as to whether Obus and the other defendants engaged in conduct amounting to insider trading in violation of the Securities Exchange Act of 19342 and Rule 10b-53 promulgated thereunder, the Second Circuit vacated the district court’s decision to grant summary judgment in favor of the defendants.4 However, the significance of the Second Circuit’s decision is not limited to its revival of the SEC’s complaint. Perhaps more importantly, the opinion offered a longawaited resolution to the question of the degree of knowledge a tippee5 must have in order to satisfy insider trading’s scienter element.6 The Second Circuit opined that sufficient scienter exists when the “tippee knew or had reason to know that confidential information was initially obtained and transmitted improperly” and “the tippee intentionally or recklessly traded while in knowing possession of that information.”7 This Note argues that by adopting both a negligence and actual knowledge standard in SEC v. Obus,8 the Second Circuit failed to provide a practical resolution to the apparent tippee scienter conflict. Part I provides a brief overview of the seminal Supreme Court cases that define the ambits of insider trading regulation and outlines the theoretical inconsistency in the Supreme Court’s approach to tippee scienter. Part II sets forth the facts and procedural history of Obus and provides the details of the Second Circuit’s decision. Part III contends that by adopting the conflicting language without offering a workable application mechanism, the Second Circuit merely 1. SEC v. Obus, 693 F.3d 276 (2d Cir. 2012). 2. Securities Exchange Act of 1934, ch. 404, 48 Stat. 881 (codified as amended at 15 U.S.C. §§ 78a–78ee (2006 & Supp. IV 2011)). 3. 17 C.F.R. § 240.10b-5 (2012). 4. Obus, 693 F.3d at 279. 5. A “tippee” is an individual who trades in securities on the basis of nonpublic information obtained from a corporate insider or misappropriator. The types of individuals considered to be “insiders” include officers, directors, and majority and controlling shareholders. In re Cady, Roberts & Co., 40 S.E.C. 907, 912 (1961). In this Note, the term “misappropriator” is used to describe an individual, such as an independent certified public accountant or outside legal counsel, who misappropriates confidential corporate information to which he or she had legitimate access. United States v. O’Hagan, 521 U.S. 642, 652 (1997); see also infra text accompanying notes 25–26. 6. Obus, 693 F.3d at 287–88. Scienter is the “degree of knowledge that makes a person legally responsible for the consequences of his or her act or omission.” BLACK’S LAW DICTIONARY 1463 (9th ed. 2009). The Supreme Court, in Ernst & Ernst v. Hochfelder, 463 U.S. 646 (1983), adopted scienter as an element of section 10(b) and Rule 10b-5 liability. 7. Obus, 693 F.3d at 288. 8. 693 F.3d 276 (2d Cir. 2012). VISSICHELLI.OFF_TO_WEBSITE (DO NOT DELETE) 2013] 2/28/2013 1:32 PM INTENT TO RECONCILE 765 solidified the incongruity surrounding tippee scienter rather than providing for a remedy. Part III further argues that the Second Circuit undermined the connection between insider trading and fraud by adopting a negligence standard. I. BACKGROUND A. Liability for Insider Trading: An Overview of the Supreme Court’s Interpretation of Section 10(b) and (...truncated)